Exists when a country can produce a good or service at a lower cost than other countries

L.5 Automatic Indexing

It may be pointed out that the advent of computer and its application in information retrieval work have given rise to some automated indexing systems. Automatic indexing or auto-indexing, as the term itself suggests, is indexing with the help of machine, i.e., without using human intellect. In other words, it is producing index using computer. In contrast, the index produce by humans using their intellect can be called human indexing. “Human indexers use their knowledge to find the ‘aboutness’ of the writing they are analyzing. They can find concepts within the writing and then use terms to help the searcher connect to that writing” [3]. In automatic indexing, “humans are involved with creating the programs for the computers and in setting the parameters, but the work is done by computers” [3].

3.1.1 Theories of space and location

4 Policies and the Indirect Impacts of Institutions on Comparative Advantage

An important impact of institutions on comparative advantage—and one that we have ignored to this point—arises due to the impact of institutions on intervening factors that in turn affect trade flows. While few papers have examined this indirect relationship directly, there are well-developed literatures showing that: (i) domestic institutions have important and sizeable impacts on many aspects of an economy, such as the accumulation of factors of production and the implementation of economic policies, and (ii) these factors are important for comparative advantage.

Yeaple and Golub (2007) examine the impact of roads, telephone lines, and electrical power generation facilities on comparative advantage and find that roads and electrical power affect comparative advantage, but telecommunications infrastructure does not. These findings complement earlier work by Clague (1991a,b), providing indirect evidence of transportation and communication infrastructure as being important for comparative advantage. In addition, a number of studies (e.g., Romalis, 2004) have shown that a country’s stock of physical and human capital are important sources of comparative advantage. Therefore, by affecting the accumulation of infrastructure, education, and capital, domestic institutions also have an indirect impact on comparative advantage.

Institutions not only affect the aggregate endowments of factors in a society, but also their distributions. This is significant since a number of theoretical and empirical papers document the importance of endowment dispersion (inequality) for comparative advantage. These include Grossman and Maggi (2000), Grossman (2004), Ohnsorge and Trefler (2007), and Bombardini et al. (2012). This is another indirect mechanism through which institutions affect comparative advantage.

An additional indirect channel occurs due to the impact of institutions on per capita income. As hypothesized by Linder, per capita income can itself be a source of comparative advantage and affect the pattern of trade. Hallak (2010) provides empirical evidence consistent with income being a source of comparative advantage. Essaji (2008) empirically uncovers another way that underdevelopment may affect comparative advantage. He shows that less-developed countries, with limited human resources and bureaucratic capital, have a comparative disadvantage in the production of products that are heavily exposed to technical regulations. Using data on countries’ exports to the United States across 4019 products, he shows that countries with better capacity to meet technical regulations specialize in sectors that have more technical measures.

Turning to policies, Nunn and Trefler (2010) have shown that countries with poor domestic institutions also tend to have tariff structures that are biased toward less skill-intensive industries, which in turn through a dynamic process reduces a country’s comparative advantage in skill-intensive industries. Therefore, through endogenous trade policies, domestic institutions can impact comparative advantage.

Once one begins to think about indirect impacts of domestic institutions on the pattern of trade, the potential channels soon become overwhelming. We have simply noted a few here.

Traditional, Endowment-Based Comparative Advantages

Proposed by Ricardo, the comparative advantage framework considers the natural and physical resources of a nation, including its labor force, as the basic criteria for specialization. Given that many developing countries initially face labor abundance, as revealed by Lewis (1954), they are advised to specialize in labor-intensive sectors. Consistent with Hecksher–Ohlin trade theory or its variations (Kahn, 1951; Sen, 1957), capital–labor ratio is a key variable in such a criterion. Despite some criticisms, this allocation criterion is useful and workable because the shift of the industrial structure from agricultural sectors to labor-intensive manufacturing sectors characterizes the typical process of development and structural transformation (Kuznets, 1966).

However, this investment strategy does not offer any answers as to what countries must do when the increasingly scarce and expensive labor drives them to enter capital-intensive sectors. An exemplar country is South Korea, which started out as a labor-surplus economy in the 1950s and later experienced an economic boom after entering the labor-intensive manufacturing sector. In the early 1970s, South Korea reached the Lewis turning point of scarce labor, during which the rapid growth of light industries increased the wage rates, thereby driving the country to enter capital-intensive sectors (i.e., automobile, steel, shipbuilding, and chemicals) in the mid-1970s. Given the large number of capital-intensive sectors, nations need to be guided as to which sector they must enter. However, the endowment-based theory of comparative advantages neither distinguishes one capital-intensive sector from another, nor suggests a criterion for choosing among these sectors.

4.2 Trade and labor markets

If trade is driven by Ricardian comparative advantage, then trade liberalization will result in a reduction in unemployment. However, trade driven by Heckscher–Ohlin is expected to reduce unemployment only if the country in question is labor-abundant (Dutt et al., 2009). Although both importing and exporting activities may create an internal restructuring process and bring about efficiency gains (Halpern et al., 2005; Wagner, 2007, 2012Wagner, 2007Wagner, 2012), the impact on employment is more uncertain (Lo Turco and Maggion, 2013). Whether trade affects the level of equilibrium unemployment is “primarily an empirical issue.” Yet, “there is very little empirical work on the aggregate employment effects of trade policies” (Davidson and Matusz, 2004; Felbermayr et al., 2011). For example, imported inputs (parts and components) may directly substitute for domestic labor with a consequent reduction in employment. However, imported inputs enhance the possibilities for improving competitiveness and leading to an expansion of the scale of output and, thus, of employment.

The labor market effects of vertical specialization have become increasingly important from a policy point of view because they are closely linked to the concepts of economic upgrading within inclusive growth. Economic upgrading sometimes translates into improvements for workers (Barrientos et al., 2010; Milberg and Winkler, 2011). The growth of intermediate imports and the insourcing of higher skill intensive production stages might drive an increase in skill intensity in the developing country manufacturing sector (Feenstra and Hanson, 1997). Fajnzylber and Fernandes (2004) contrast China and Brazil. In the former, importing or exporting intermediates is associated with stronger demand for skilled labor. In Brazil, however, the opposite is true. The reasons for this difference are the simple assembly or the extent of processing trade (ie, export of final goods based on assembly of imported intermediates) undertaken in China relative to Brazil (Shepherd, 2013). Dai et al. (2011) found that exporters in China are generally larger than other firms, although the effect is muted somewhat for firms engaged in processing trade. Feenstra and Hong (2007) showed that using China’s employment/export ratios from earlier years to forecast the country’s employment growth from 1997 to 2005 would result in serious overestimates, because the employment/export ratios changed significantly due to changes in wages, technological progress, and changes in export composition.

In sum, overall declines in unemployment with trade opening can be shown, but this outcome will be influenced by the labor market conditions.

Comparative Advantage

To provide an exact operational meaning of comparative advantage as it is used in neoclassical economic theory, it is necessary to examine the equation of the aggregate assumption of household assumed in Becker's original formula. An aggregate consumption Z of the household of a husband and wife is as follows:

Z=Z(x,th′)=Z[α(wtpm/px)+wtp w/px,β(thm)+thw] .

This formula of aggregate consumption is composed of market goods (x) and household goods (t′h, represented by the effective amount of housework hours), and both the man and the woman produce both types of products. The amount of goods consumed is the sum of goods earned due to the man (αw is the wage rate, tpm is the amount of time spent on paid work by the man, and px is the price for goods) and due to the woman (wtpw/px). Household goods also derive from the man's housework hours (βthm) and from the woman's housework hours thw. The husband has a comparative advantage in the market sector relative to the woman if and only i

∂Z/∂tpw∂Z/∂t hw<∂Z/∂tpm∂Z/∂t hm,

which means that α > β in the previous equation. The husband has a comparative advantage in the market sector if and only if the marginal product ratio in the market sector (vs. the housework sector) for the husband is greater than the marginal product ratio in the market sector (vs. the housework sector) for the wife. However, to measure the marginal product ratio for each spouse is not straightforward because a valid, reliable price for housework is not available. Under the assumption that marginal product in the housework is the same for each spouse, wage rate can be used as a proxy for the comparative advantage. However, even obtaining wage rate is complicated because there are people who do not currently work (or even never work). For those people, it is possible to use an estimated wage rate based on factors such as years of schooling, estimated years of job experience, gender, and race.

Type I: Catching-Up Industries

How can governments identify industries with latent comparative advantages in the process of catching up with industries in higher income countries? History offers many lessons of what to do and what to avoid.

Since the 16th and 17th centuries, successful economies have shared a common feature: industrial policies in these countries aimed to help firms enter the industries that had flourished in dynamically growing and slightly more developed countries. They were able to exploit the latecomer’s advantage. For example, the Netherlands was the most developed country in the world in the 16th and 17th centuries, with a highly developed wool textile industry. Britain’s wool textile industry was immature by comparison. The British government implemented policies to encourage the imports of machinery and skilled workers from the Netherlands. Those policies worked. At the time, per capita income in Great Britain was 70% of the Dutch level. That meant that their endowments and comparative advantages were quite similar.

Following the Industrial Revolution, Great Britain became the most advanced economy in the world. In the late 19th century, France, Germany, and the United States used similar policies to catch up with Great Britain. Their per capita incomes at that time were already about 60%–75% of Britain’s (Gerschenkron, 1962). In the 1950s and 1960s, Japan imitated industries in the United States at a time when its per capita income exceeded 40% of that of the United States. Later, the four Asian tigers (Korea, Taiwan, Singapore, and Hong Kong) succeeded by imitating Japan’s industries. Their per capita incomes were about 30%–40% of Japan’s at the time (Akamatsu, 1962; Chang, 2003; Ito, 1980; Kim, 1988).

Other countries also targeted and tried to imitate industries in the United States after the WWII but failed. One reason was that their income levels were less than 20% of that of the United States. For example, in the 1950s China targeted and tried to imitate US industries even though its per capita income was just 5% of the United States level. With the government’s efforts to build up advanced industries, China was able to test atomic and hydrogen bombs in the 1960s and launch satellites in the 1970s. These achievements came at a very high price to the economy. In 1979, when China began its transition to a market economy, its per capita income was less than one-third of the average of sub-Saharan African countries.

Drawing on the experience of successful economies and the theory of comparative advantage, I propose a new growth identification and facilitation framework for the catching-up type of industrial policy. This framework has two tracks and six steps (Lin and Monga, 2011).

Step 1. Identifying tradable goods industries. When the government of a developing country seeks to facilitate industrial upgrading in nonresource manufacturing, it should identify the tradable goods industries in countries that have been growing dynamically for the previous 20–30 years and whose per capita income is about 100%–200% higher than its own. Although experience suggests that 100% has been a successful reference point, a larger leap could be justified because technology and industrial upgrading happen much faster today.

The tradable goods and services produced in the target countries have a good chance of being those in which the pursuing country has a latent comparative advantage. If a country has grown rapidly in the last 20–30 years, the industries in its tradable sectors must be consistent with its comparative advantage. Yet, because of rapid capital accumulation and wage increases, the industries that were consistent with the comparative advantages of the targeted country’s previous factor endowment structure will soon lose their comparative advantage. The sunset industries that are about to lose their comparative advantage in the targeted country will become the sunrise industries because of latent comparative advantage in the catching-up country, which has a similar endowment structure and a somewhat lower per capita GDP.

Step 2. Identifying obstacles. Among the industries identified in step 1, the government may give priority to those which some domestic firms have already entered spontaneously, and identify the obstacles impeding these firms from upgrading the quality of their products and the barriers limiting entry by other private firms. The usual barriers are related to high transaction costs. Is the primary impediment deficient infrastructure, poor logistics, inadequate financial support, or a limited pool of skilled workers? Obstacles can be identified using value-chain analysis or the growth diagnostic framework suggested by Hausmann et al. (2008). The government can then take steps to ease those binding constraints, using randomized controlled experiments to test the effectiveness of these measures before scaling up policies at the national level (Duflo, 2004).

Step 3. Encouraging firms in other, more advanced economies to relocate to the country trying to catch-up. Some of the industries identified in Step 1 may be new to the country. The government could adopt measures to encourage firms in the targeted higher income countries to relocate to its country so as to take advantage of lower wages. The government could also establish incubation programs to catalyze the entry of domestic private firms into these industries.

Step 4. Paying attention to successful businesses in new industries. Technology changes fast, which means that there are industries today that did not exist 20 years ago. Some domestic entrepreneurs may discover new profitable opportunities that were not identified in step 1. Consider information services in India in the 1980s. In the beginning, Indian firms outsourcing to US companies used satellite communication, which was extremely expensive. The Indian government built fiber-optic systems that greatly reduced communication costs, helping Indian information service companies gain a competitive advantage over other companies in the world. When new technology brings new opportunities and domestic private firms have already discovered them, the governments should pay close attention to their success and provide support to scale up those industries. Each country may also have some unique endowments. If entrepreneurs in the country discover opportunities to use such endowments profitably, the government may also provide support to scale up those opportunities to become competitive industries.

Step 5. Using special economic zones to attract domestic and foreign companies. In developing countries with poor infrastructure and an unfriendly business environment, budget and capacity constraints prevent governments from making necessary improvements to benefit every industry in all locations of the country within a reasonable timeframe. Instead, the government can use industrial parks, export processing zones, or special economic zones to attract private domestic and foreign firms to invest in the targeted industries. Improvements in infrastructure and the business environment within these special areas can reduce transaction costs and facilitate the development of industries with latent comparative advantage. The special economic areas also have the advantage of encouraging industrial clustering, which can lower logistical costs.

Step 6. Compensating pioneering firms for the externalities they generate. The government may provide limited incentives to pioneering domestic or foreign firms that invest in industries identified in steps 1 and 4 to compensate them for the public knowledge created by their investments. The incentives should be limited in time and budget allocations because the targeted industries should have a latent comparative advantage that enable them to become competitive in domestic and foreign markets once transaction costs fall. The incentives may be in the form of a corporate income tax holiday for a limited number of years, priority access to credit (in countries with financial repression), or priority access to foreign reserves for importing key equipment (in countries with capital controls). To minimize the risk of rent seeking and political capture, the incentives should not be in the form of monopoly rent, high tariffs, or other distortions. The government may reward the firms that discovered successful new industries by themselves (see step 4 aforementioned) with a prize or other forms of special recognition for their contributions to economic development.

This kind of compensation for externalities differs from the protections and subsidies of the old import-substitution strategy that aimed to help nonviable firms in priority industries stay in business. Under this new framework, the firms encouraged have low factor costs of production and are viable in the market, so their profitability can be ensured by improving their management once soft and hard infrastructure are enhanced and transaction costs lowered.

3 The Heyday (1950–1980)

No doubt, the pre-war initiatives, mentioned above, were crucial for the postwar expansion of economic history to become one of the main disciplines of the economic and historical sciences, but several new initiatives taken after World War II by economists and economic historians alike were as decisive. During the immediate postwar decades, the Anglo-Saxons clearly dominated the scene of innovation. Keynesianism became the great fashion in economics, but it was soon complemented by theories of economic growth. The more dynamic approach of the growth theories stimulated the interest of the American economists, such as Moses Abramovitz and Colin Clark, in long-term economic-historical development. In 1950, during the Paris world conference of historical sciences, Clark incited the economic historians to join the economists in taking up research on long-term economic growth. The appeal was heard. At the end of the 1950s, the American Economic History Association and the National Bureau of Economic Research were joining efforts in studying the evolution of income and wealth in the United States during the nineteenth century. During the first international economic history conference in Stockholm in 1960, themes on industrialization, human capital, and technology as factors of economic growth became predominant in the modern history sessions. Based on historical experience, concepts and theories on the ‘take-off’ (Walt W. Rostow), on the ‘great spurt’ (Alexander Gerschenkron), and on capital formation and capital utilization (Evsey Domar) were formulated.

Soon the scope of the discussions widened, leading, inter alia, the following new questions.

(a)

Had planned economies a comparative advantage or disadvantage vis-à-vis the free-market economies in promoting economic growth?

How to explain regional growth disparities in the West from a historical point of view?

How to explain uneven economic development in the world?

Finally, how to specify the links between growth and income?

The last question would be analyzed in depth by Nobel Prize winner, Simon Kuznets (1901–1985), who started to use reconstructed historical series of national accounts for that purpose, emphasizing that economic growth could only be studied scientifically if it was based on trustworthy macroeconomic statistics. Kuznets' appeal would generate a large-scale research movement of reconstructing national accounts. Phyllis Deane and W. A. Cole's successful book British Economic Growth, 1688–1959, first published in 1962, used such statistics, and encouraged the movement still further. Scholars in the United States, France, Germany, Belgium, the Netherlands, Spain, Switzerland, Sweden, Finland, and Portugal were launching projects to reconstruct historical national accounts of their own countries. In the United Kingdom, Charles Feinstein, Nicholas F. R. Crafts and others soon would start working on correcting and improving the estimates of Deane and Cole. Research on the links between growth and income, on the other hand, increased interest in the social aspects of growth and development. Marxist and non-Marxist economic historians in the following years would expand this field of research very much, emphasizing the importance of socio-institutional factors in the process of growth and development.

As far as the economic history of the Ancien Régime was concerned, the influence of Michael M. Postan (1899–1981) was prominent during the immediate postwar years. His long-term Malthusian demographical approach would become a model of interpretation for European economic development during the Middle Ages as well as during the early modern period. The Postan model would lead to the creation of the Cambridge Group for the History of Population and Social Structure under the directorship of Edward A. Wrigley, Roger S. Schofield and Peter Laslett. The French would join the English Malthusian demographical approach, although Michel Fleury, Louis Henry, Jean Meuvret and Pierre Goubert analyzed short- and medium-term demographical fluctuations in particular. For that purpose, Fleury and Henry would introduce the prosopographical method into historical demography and develop a method for family reconstitution based on the information in the parish registers. Emmanuel Le Roy Ladurie, on his part, would integrate, somewhat later, Postan's long-term model into his own research on French and European agricultural history in the early modern period.

During the same period the Annales School, now firmly dominated by Fernand Braudel, was extending its influence via the Ecole Pratique des Hautes Etudes de la Sorbonne, not only among the French economic historians, but also in the whole of Europe and soon beyond. From the late 1950s onwards until the early 1980s, the School would inspire a large part of economic historical research on:

(a)

The late Middle Ages (for example Georges Duby and Jacques Le Goff).

The early modern times (for example Pierre Jeannin, Jean-François Bergier, Pierre Deyon, Bernard H. Slicher van Bath, Jerzy Topolski, Pierre Chaunu, Felipe Ruiz Martin and Herman Van der Wee).

The French Revolution period (for example François Furet and Denis Richet).

Originally, research was often focused on geographical studies of economic development, following the example of Braudel's pioneering study on the Mediterranean, but, in contrast to Braudel, most of these studies combined qualitative approach with quantitative analysis. Gradually, the qualitative ‘global history’ approach became predominant. Within this framework, under the influence of Marxist economic historians such as Immanuel Wallerstein, the socio-institutional aspects were getting increasingly more attention in the analysis of the agricultural, commercial, industrial, and financial development of Europe during the Ancien Régime.

While the methodological trend in the Annales School from the 1950s onwards was moving in the direction of a more qualitative approach to economic history, in the United States the trend during that period moved clearly in the opposite direction. In 1954, at Purdue University in Lafayette (Indiana), economists and economic historians already used primitive computers for the processing of statistical data. Three years later, during a conference of the American Economic History Association in 1957, Alfred H. Conrad and John R. Meyer launched the idea of a ‘New Economic History,’ aiming at integrating economic theory, quantitative methods, and history into one discipline. They illustrated the relevance of their idea by applying a microeconomic input–output method when analyzing the profitability of slavery in the American South during the nineteenth century. Nobel Prize winner Robert Fogel and Stanley L. Engerman later took up the theme. This led to a large-scale research project, its conclusions being published in Time on the Cross, 1974.

Some young economic historians received Conrad and Meijer's idea with enthusiasm. It gave birth to ‘Cliometrics,’ soon a well-established subdiscipline of American economic history. In the early 1960s, Robert P. Thomas had already applied the cost–benefit analysis method to explore the effects of the British Navigation Laws on the economy of the American colonies. More spectacular was the research undertaken by Robert Fogel and Albert Fishlow on the contribution of the railroads to American economic growth. To measure their impact, Fogel constructed a hypothetical world and used a counterfactual proposition: what would have happened to an economy if, contrary to the facts, one or more important features of that economy had never existed? Or applied to his research: if a railway system had not been introduced in the United States during the second half of the nineteenth century, could an alternative transport system, such as a system of existing and new canals, have generated as many social gains and dynamic effects as the railways did? The results of Fogel's cliometric test were fascinating: the difference would have been minimal since the ‘social savings’ would have represented less than 5 percent of national income in 1890. The cliometricians, now organized in an autonomous association, the Cliometric Society, and holding their own yearly meetings, began revisiting all major themes of American economic history, hoping that their methodology would lead to a complete reinterpretation of that history. Major themes studied by the cliometricians were:

(a)

the economic reconstruction of the South after the Secession War;

the impact of labor and migration on American growth at the end of the nineteenth century (cf. the model of Jeffrey Williamson, applying macroeconomic equilibrium theories);

money markets and banking systems as factors of growth in the United States in the nineteenth century;

the American Industrial Revolution;

the Great Depression of the 1880s;

the World Crisis of the 1930s; and

the role of the residual factor in American productivity growth.

The methodological innovation, introduced by the American New Economic History, would spill over to the rest of the world, in particular to Canada, Australia, and some European countries, particularly the United Kingdom, Germany, France, and Sweden. Moreover, from 1970 onwards each world congress of the International Economic History Association would have a session on methodology, dominated from the beginning by the American cliometricians. However, the impact of the New Economic History outside the United States remained limited and certainly did not gain widespread recognition. F. Redlich, for example, described the counterfactual deduction in 1968 as ‘fictitious history’ and ‘not history at all.’ Was it because neoclassical theory was found to be less applicable to the European pre-industrial period than to the nineteenth-century American economy? Alternatively, were institutional factors, such as the separation between economists and economic historians who are normally active in the arts faculties, responsible for the emotional aversion towards the blend of history, economic theory, and econometrics? Even in the United States itself, dissidents soon emerged. Nobel Prize winner Douglass North, who had been applying the New Economic History methods in his studies on American growth, withdrew from cliometrics and reoriented his research to the institutional aspects of growth, using the historical experience to construct and verify his hypotheses. In his view, the protection of ‘property rights’ and the lowering of ‘transactions costs’ were the decisive factors in the history of economic growth. In the same vein as North's New Institutional History, but more innovating and with a much larger impact in and outside the United States, was Alfred D. Chandler Jr's founding of the ‘New Business History.’

When creating the Center of Entrepreneurial Studies at Harvard in the late 1930s, Joseph Schumpeter and Arthur Cole had hoped to replace the hagiographical tradition of prewar and interwar business history by a more scientific approach. However, it was Chandler who, from the 1960s onwards, realized that ambition fully with his books Strategy and Structure (1962), The Visible Hand (1977), Scale and Scope (1990) and Inventing the Electronic Century (2001). Careful historical investigation, combined with in-depth institutional economic analysis, revealed the crucial role of business management and business organization in the successful rise of American capitalism. This was soon completed by studies on the rise and development of European and Japanese capitalism. Chandler's hypotheses and methodology became standard all over the world and are still so. Up to the present day, they are the main source of inspiration to the ‘New Business History.’ A last new economic history group, emerging after World War II, should be mentioned: the ‘New Urban History,’ integrating sociological, geographical, and economic theories and quantitative methods into the historical analysis of towns and urbanization. In 1962, an interdisciplinary Urban History Group was established, followed three years later by the ‘Commission Internationale pour l'histoire des villes’ directed by scholars such as Henri Aubin, Hektor Ammann, and Philippe Wolff. However, the Anglo-Saxon historians, once again, were pioneers in the field, H. J. Dyos, Jan de Vries, Paul M. Hohenberg, Lynn Hollen Lees, Peter Clark and many others.

Postwar economic history was also influenced by the social effects and economic problems generated by the spectacular expansion of the Western economy during the postwar period. Indeed, research was much inspired by the increasing number of publications, such as the report of the Club of Rome (1972), revealing the problems caused by economic growth, or by movements protesting against the negative effects of growth in the West, such as the activist policies, formulated by the UNCTAD in the course of the 1960s and 1970s. Responding to these reactions, new themes emerged in the programs of the world conferences of the International Association of Economic History. These included, from the 1970s onwards, in particular: ‘Natural Resources and Economic Development in History,’ ‘Oil in the World Economy,’ ‘Environment and Urbanization in History,’ ‘Ecological History,’ ‘The Economic History of Leisure and Recreation,’ ‘Typology of Colonial Economic Development,’ ‘The Economic History of the Third World,’ ‘Loans, Debts and Economic Development in the Nineteenth and Twentieth Centuries,’ inter alia. The Cold War and its ideological conflicts would lead to a number of studies comparing the efficiency of the two economic systems in an historical perspective.

3.1 An Approach Based on Comparative Advantage

The Roy model (1951) of comparative advantage provides a useful starting point. Heckman, Stixrud, and Urzua (2006) use the Roy model to introduce psychological variables into the study of social and economic outcomes.36 Personality traits are treated as endowments, and choices are determined by personality traits and other factors as they affect productivity in skills.

Agents can perform one of J tasks with productivity Pj, j ∈ {1,…,J}. The productivity in task j depends on the traits of agents represented by θ and the “effort” they expend on the task, ej:

(1.1)Pj=ϕj(θ,ej ),j∈J={1,…,J},ej∈E,θ∈Θ.

The traits are the endowments of agents that govern behavior. Examples of traits include height, personality characteristics, problem-solving ability, and strength. θ is a public good as it is available in the same amount for all tasks. Productivity also depends on effort ej. Effort is assumed to be divisible and fixed in supply.

In much applied research, effort and traits are often assumed to be measured so that over the relevant range, assuming differentiability with respect to ej and θ,

∂ϕj∂ej≥0and∂ϕj∂θ≥0,

but neither condition is strictly required. Excess effort (overexertion; too much attention to detail) may be counterproductive so that function ϕj need not be monotonic in ej, contrary to what is assumed here. Indeed, as discussed in Section 5, certain psychopathologies are associated with extreme levels of traits that are quite productive at normal levels. Different traits may have different productivities in different tasks, leading to comparative advantage in different tasks for people with different endowments.37

Efforts may complement traits (∂2ϕj∂ej∂θ′>0) or may substitute for them (∂2ϕj∂ej∂θ′<0). A variety of intermediate cases might exist where some effort-trait relationships are complementary and others are substitution relationships. Some people may solve complex math problems with no effort, whereas others may have to allocate considerable time and effort to achieve the same result. Effort can be a vector (time, mental energy, attention), and it is assumed to be a divisible private good with the feature that the more that is applied to task j, the less is available for all other tasks at any point in time. ∑j=1Jej=e¯ where e¯ is the endowment of total effort. Baumeister, Bratslavsky, Muraven, and Tice (1998) interpret self-control as a component of e that is fixed over given time periods. A person who exerts more self-control in one task may be less self-controlled in another task.

Let Rj be the reward per unit productivity in task j. In the first case we analyze, agents can productively engage in only one of the J tasks at any time. This restriction can be interpreted as a case in which effort can only be applied to a single task. A reward-maximizing agent with trait θ and endowment e¯ faces the problem of picking the maximal task to perform, j⌢ where

(1.2)j⌢=argmaxj∈{1,…,J}{Rjϕj(θ,e¯)}.

In this case, θ and e¯ play the same role. People with different effort and capability endowments will generally choose different tasks.38,39Heckman, Stixrud, and Urzua (2006) show how persons with different endowments of personality and intelligence sort into different occupations and levels of schooling. People low in certain traits may have better endowments of effort and may compensate for their shortfall in ability by exerting effort. For certain tasks (e.g., creating new branches of mathematics), there may be threshold levels of θ such that for θ<θ¯j,ϕj(θ,ej) =0 for all ej<e¯. (The person needs a given level of trait θ, no matter how hard they try.) The higher Rj, the more likely will the person choose to perform task j. The particular choice of which j to perform depends on the productivity of traits in different tasks.

Concluding remarks

As stated earlier, no better example of dynamic comparative advantage can be found than China. Over the past 35 years, China’s economy has undergone rapid transformation. However, little research has been done into the underlying economic forces facilitating this economic transformation. In this chapter we focus on the linkages between the way in which China’s foreign trade has evolved, change in the pattern and structure of the country’s comparative advantage, and the way in which China’s economic structure has continually transformed. The processes involved in structural transformation and the shift of comparative advantage across sectors have been formalized using the theoretical model of Lim and Feng (2005). Based on this model, we use specialization indexes to proxy for the intensity of comparative advantage. Empirical analysis shows that since the 1990s the specialization index of primary goods has been steadily declining while that of manufactured goods has been climbing. Moreover, of the various subdivisions of primary goods, the specialization index of mineral fuels, lubricants, non-edible raw materials and related products has been steadily falling while, of the various subdivisions of manufactured goods, the specialization index of machinery and transport equipment has been steadily rising since the 1990s. Empirical results largely support the hypothesis of the theoretical model presented in this chapter.